Apple dresses up fund managers’ appeal

Commentary: Investors should watch for racy stocks in conservative portfolios

BOSTON (MarketWatch) — One reason investors buy mutual funds is for exposure to big names and hot stocks. Nowadays you can’t get any bigger and hotter than Apple Inc.

Not surprisingly, Apple is a mutual-fund staple, accounting for more than 5.5% of the average large-cap portfolio, according to investment researcher Morningstar Inc.

Private equity firms profit from sustainability

(2:51)

Without quarterly obligations to stockholders, private equity firms can profit from longer-term investments in sustainability, which have less immediate returns says Carlyle Group Managing Director David Rubenstein.

But the recent announcement that Apple
AAPL, -0.87%
will pay a dividend shows how some funds use hot stocks to game the system, beat the ratings/rankings game and fool investors.

This has nothing specific to do with Apple, and everything to do with how managers run funds; to see that clearly, start with the tech giant’s recent announcement that it will pay a quarterly dividend of $2.65 per share beginning in July.

If you believe that Apple will keep growing, the fact it’s now a dividend-payer is huge. It means that equity-income managers can buy a fast-growth stock that heretofore hasn’t belonged in a fund with income/dividends as a significant part of its mission.

Window display

Here’s where things get interesting: plenty of dividend-driven fund managers already own Apple.

Based on portfolio data that was months old when Apple made its announcement, at least 10% of funds with a mandate for dividends and income actually owned Apple before it decided to pay a dividend.

Hmmm.

Now, the prospectuses for some of these funds leave plenty of leeway for the manager to go where they want, often with some specific income goal — say, exceeding the yield of the Standard & Poor’s 500 Index
SPX, -0.23%

While every equity-income manager could give some reason for buying Apple before it announced a dividend, you can file this move under “window-dressing,” which is a way managers can gussy-up a portfolio to appease investors.

Window-dressing typically occurs just before the record date for a fund to publish its holdings. A manager whose performance is lagging jettisons issues that look bad in exchange for issues that shareholders recognize and covet, hoping that when shareholders examine the holdings they’ll see a portfolio that looks better than the results it has delivered, creating hope for the future.

While managers always contend they would never diverge from their strategy for appearances sake, reality says otherwise, both in trading patterns that show up at certain times of year, but also in cases like Apple.

System malfunction

At the least, owning Apple lets a manager game the system. If the traditional equity-income stock is slow-growth and a manager forsakes the dividend mandate to get a fast-growth star such as Apple, it can make the fund look better than competition that stayed entirely within the boundaries of the category.

It’s easy to get away with. If the prospectus doesn’t prohibit it — and most don’t — the rules governing funds named for a specific asset class, such as technology or equity-income, say that only three-quarters of the fund has to be in such issues.

For example, more than two dozen small-cap and midcap funds hold Berkshire Hathaway A shares
BRK.A, -0.35%BRK.B, -0.08%
, and they didn’t all buy the stock when it was trading at $1,000 per share and ride it up to $122,000. The stock hasn’t qualified as small or midcap since before Warren Buffett was a billionaire, but he’s such an icon that the company’s presence in a portfolio comforts investors.

No one complains when the strategy works. It’s hard to criticize a manager when performance is at or above peer levels, even if those results haven’t been achieved entirely by following the fund’s mandate.

With that in mind, growth-and-income investors shouldn’t be upset if they look at their fund’s holdings and find Apple already in there; they should simply recognize that their fund manager is playing at the edge of the rules.

But when something goes wrong, it can be a shocker. That’s why so many investors were gob-smacked when the market cratered in 2008; if you don’t recognize the liberties a manager takes to turbocharge returns, you can’t see what might fuel the next potential burnout.

Ultimately, investors should examine a fund’s holdings to make sure that everything belongs. The most comforting names are securities that fit the fund’s mission.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.